At various times in certain financial environments, interest rates may be at levels that do not produce sufficient or desirable yield for investors holding investments affected by interest rate levels. Alternative options for investments, such as holding equity related investments, for example, may not be viable or attractive for investors because the risks associated with such equity related investments may not be acceptable in view of the investment objectives of the investor. In addition, tax considerations for investments closely connected with interest rate levels may be implicated by existing policies, regulations, rules and/or laws that address taxation of income, for example, derived from such investments.
In financial environments where returns on investments affected by interest rates may be relatively low, investors may seek an alternative form of principal-protected investment that provides the opportunity for adequate yield while maintaining a risk profile that is acceptable to the investor. One example of an alternative strategy may involve an equity-linked note (among other types of investment instruments that may be characterized as contingent payment debt instruments for purposes of applicable policies, rules, regulations, and/or laws governing tax treatment of such investment instruments) that is structured to pay the note holder appreciation associated with an equity market or index (e.g., S&P 500) with which the note is connected or linked. One disadvantage of the equity-linked instrument is that the note holder is generally required to accrue taxable income (e.g., original issue discount or “OID”) during the life of the note based on an assumed yield, even though the holder may not receive any coupon payment on the note prior to maturity of the instrument. Another disadvantage is that equity-linked notes are usually connected to an index or a fixed portfolio; this link does not offer the opportunity for enhanced returns that can be derived from a more dynamically or actively managed portfolio. Still another disadvantage is that an equity-linked note is typically structured to settle on a specific maturity date on which the holder receives a coupon in one lump sum that may be considered ordinary income to the holder (i.e., versus more desirable long-term capital gains treatment for the income, for example). In addition, the option to defer the coupon income received on the maturity date of the note may not be available.
Another conventional investment strategy involves maintaining a portfolio of investments such as large capitalization stocks, for example, and also employing one or more derivative arrangements (e.g., options) to hedge risk on the portfolio. In one example scenario, an investor (1) establishes a portfolio with an account manager for active management of various stock investments for the investor; and (2) purchases a put option associated with the S&P 500 index. In this arrangement, the investor is provided with the benefits of active management of the stock portfolio by the account manager, and the put option on the S&P 500 index is employed to hedge quote-on-quote market risk. A primary disadvantage to this investment strategy, however, is that there may be a relatively large and undesirable disparity between performance of the stock portfolio under active management by the account manager and performance of the hedge arrangement associated with the put option. From the perspective of the financial objectives of the investor, this strategy may introduce an unacceptable degree of risk of loss of principal assets.
It can be seen, therefore, that many conventional investment strategies and financial products do not provide the potential for adequate yield on investments in conjunction with minimizing risk to principal assets.